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DWSD suburban users may be on hook for $675M for city pensions

If authority isn't formed ...

Regional leaders said a post-bankruptcy Detroit Water and Sewerage Department would add nearly $67.5 million a year to its expenses, with little or no ability to raise capital and no significant new revenue coming from city customers. That leaves one revenue stream: the suburbs.

Suburban businesses and residents could have to pay $60 million or more per year into the coffers that pay retired Detroit employees if their elected leaders cannot agree on the creation of a new regional authority to take over the Detroit Water and Sewerage Department in the next several weeks.

The money apparently would pay the annual contributions of all city workers in the General Retirement System over the next 10 years, not just DWSD's own employees.

The bankrupt city's proposed plan of adjustment under review before Judge Steven Rhodes calls for the city to pull $675 million from the DWSD by 2023 to fund its General Retirement System — the pension plan for most of its 9,300 active city employees and 21,000-plus retirees — if no authority is formed.

That clause by itself might not draw much attention, but if Rhodes confirms the plan, then another section of it authorizes Detroit to "begin planning a rate stability program for city residents" in the system, which can in turn "provide for affordability of retail rates to be taken into account in the development of wholesale rates across the system," which are the rates charged to suburban communities.

In other words, regional leaders said, a post-bankruptcy DWSD would add nearly $67.5 million per year to its expenses, with little or no ability to raise capital for it in the bond markets and no significant new revenue coming from city retail customers. That really leaves only one other revenue stream.

Peter Provenzano, Macomb County finance director

"Right now, from what we've heard, they (DWSD) are only putting in about $10 million to the plan right now. This calls for a prefunding commitment if the authority is not created, and it's got to come from an increase in rates," said Macomb County Finance Director Peter Provenzano, who is part of the ongoing talks between city and suburban leaders

"And a majority of the suburbs are the ones taking the hit on that, in what they pay as wholesale customers."

Oakland County Deputy Executive Robert Daddow last week submitted a report to the other regional leaders in those talks, citing his business issues and questions raised by Detroit's Feb. 21 plan of adjustment. Among them are that the plan doesn't say where the DWSD gets its $675 million or whether it will pay the retirement system in one lump sum or in annual installments.

Daddow and Macomb County Assistant Executive Melissa Roy told Crain's last week that there was never a mention of a $675 million payment by DWSD to the pension in their ongoing authority talks with the city before the plan of adjustment surfaced in court. It still has not been fully explained to the regional leaders, they said.

Robert Daddow, Oakland County deputy executive

"If no authority is to exist, the DWSD would be expected to advance fund this amount over the next 10 years, which would then allow the city's general fund to avoid having to make pension plan contributions. That money they pay into the plan now would be freed up to buy improvements in technology and infrastructure," Daddow said.

"But why is the DWSD expected to be able to come up with this extra money for the rest of the city, when it (the department) already has about $2.5 billion to $5 billion of capital improvement needs itself?"

Nowling told Crain's the city is not able to discuss the pension payment or "rate stability" proposals within the plan because they are part of ongoing negotiations with neighboring county officials discussing the authority.

"The simple answer is that many of those (plan) details are yet to be determined or fleshed (out) beyond negotiation points," he said via email.

At a loss

The department, which services a nearly 1,100 square mile area and 43 percent of Michigan's population, had operating income of about $140.2 million before debt service and investment losses during the fiscal year ended last June 30, according to preliminary unaudited budget figures submitted to the department's Board of Water Commissioners last month.

With debt interest payments, depreciation, lost investments and other nonoperating costs, the department's 2013 net loss was actually $146.6 million. Net losses in 2012 were about $39.5 million, and Daddow in his March 3 report to the other negotiators in authority talks estimates that the department has lost $1.5 billion over seven years or more than $200 million a year.

The debt load that creates the department's current loss would be considerably reduced if Rhodes approves the city's current adjustment plan. Six classes of water and sewer bondholders who collect debt interest payments from the city now become impaired creditors, who would take less than what they're owed from the city on those bonds.

Daddow said the suburban payers would still have to cover whatever net loss remains for the department post-bankruptcy, plus another $67.5 million per year if the department has to raise the extra funds for the pension plan by 2023, over and above a $29 million credit that city customers already receive on their rates, offset by wholesale customer rates charged to suburbs.

The city has about 9,300 active employees, including 1,531 water-sewer employees, who are covered by either the general retirement system or the Police and Fire Retirement System now. But the restructuring plan calls for the DWSD to be the sole city agency paying into the general system for about 10 years after the city exits bankruptcy.

Tactic for talks?

Suburban leaders said the proposal, besides freeing up some general fund money that the city contributes to the general retirees plan now, may also be a tactic by the city to keep regional talks moving to form a Great Lakes Water and Sewer Authority that would lease department assets and assume its costs.

That authority would lease the assets for a minimum of $47 million a year over 40 years — although past proposals in talks have called for as much as a $9 billion lease over the same period, or more than $220 million per year.

News that water-sewer bondholders will take a haircut in the plan isn't well received everywhere. Fitch Ratings Ltd. downgraded the department's rating on senior and second lien water and sewer bonds from BBB+ to BB+ and BBB to BB, respectively, on Feb. 28 and said a confirmation of the plan could only push the department's rating deeper into junk status.

"Fitch would almost certainly view the court's confirmation of the (plan) or a similar variation whereby bondholders are impaired, as a distressed debt exchange leading to a ratings downgrade to as low as D," Fitch said in a statement on the downgrade.

Bond attorneys contacted by Crain's last week said they could not recall any Michigan municipal government or authority being able to issue bonds with a C or D junk rating, and regional leaders said borrowing to cover the pensions essentially would be off the table.

If the new authority takes over the department, it can create its own pension plan and freeze the current defined benefit plan covering current department employees, Daddow said. But regional leaders believe it would also need the funding to cover at least $2.5 billion in vital infrastructure improvements.

"They're looking to whack the current bondholders in the plan, but one of the things we understand if an authority is formed that investors are probably not too eager to reinvest in you at a new, lower rate," Provenzano said.

"There is also information we still need from the city and haven't received yet. Because one of the assumptions in helping to fund the new authority is that the new authority would get an A bond rating. We're doing some research on that because we don't know that that's necessarily the case. And if it isn't, then our borrowing costs only get higher."

Exploring options

Daddow said Oakland County is in meetings with bankruptcy attorneys to consider its options about the adjustment plan, including whether it has any standing to object to it in court.

He and Provenzano both said if no authority is created by April 14, then presumably all creditors vote on a restructuring that keeps the DWSD as a city department when ballots go out to creditors that month.

Roy said Macomb County is in talks with officials in Lansing about its options as well, and it's possible that the city's plan could be open to a challenge under Section 904 of the U.S. Bankruptcy Code, which prohibits the court from interfering with a debtor's revenues or property without its consent.

She also said Macomb County residents are sympathetic to the plight of Detroit pensioners but have concerns of their own.

"These are people who live in places like Martin and Gratiot (Avenue), or 12 Mile (Road) and Groesbeck, and have to cover this out of the bills they pay every day. This can't be about whether we ought to shore up these people (pensioners) by making other impoverished people suffer for them," she said.

"And we still, when this is all done, have to remain a competitive region in terms of economic development by what we charge to water and sewer customers. Otherwise we are going to risk impoverishing more people with lost job opportunities and investment."